The Essence of a Distribution Agreement
Distribution agreement contracts serve an essential function in most business transactions. Essentially, a distribution agreement is a binding contract between a supplier or producer of products and a distributor. Typically, the manufacturer or supplier is the one who draws up an agreement that outlines their proposed terms. A distribution agreement can be a lengthy, complex document that covers all aspects of the supplier-distributor relationship, or it may be just a short letter agreement or a one-page form.
Contracts can be used for both formal and informal distribution agreements. Most of the time when we think of distribution agreements , though, it is in relation to formal deals involving suppliers of consumer packaged goods and mass-market distributors such as grocery stores or gas stations. However, they can also be drafted for informal arrangements such as small goods producers who hire a local store to sell their products for a fee. Or perhaps a retailer sells a certain product for a fee to consumers through its website. Any of these instances would require a distribution agreement.
Components of Distribution Agreements
A distribution agreement is a contract wherein the manufacturer or supplier of a product provides that product to a distributor or distributor for resale to end customers or the general public. The distributor serves as a middleman between the manufacturer and the consumer. Distribution agreements can apply to both tangible goods and intangible products and services.
Distribution agreements often cover enterprise-wide products or services "resold" by resellers and wholesalers in various markets. The primary purpose of a distribution agreement is to establish one or more legal relationships between the parties that allow it to serve as a framework for its respective businesses over a pre-determined period.
Like many agreements in business, the terms of the agreement must be decided and included at the outset. The expansive nature of potential distribution agreements reflects the incredibly wide range of businesses that may exist. However, distribution agreements still include certain crucial provisions. Chief among them are:
• Identification of Parties. Parties subject to a distribution agreement typically are the supplier or manufacturer (hereafter "Supplier") of the product and the distributor itself (hereafter "Distributor"). This is sometimes complicated by the number of parties involved in a supply chain. The Supplier, for example, may take on the global role while local dealers and distributors exist under an intermediary agreement with the Supplier but may also be the Distributor under the distribution agreement.
• Scope. The scope of the agreement is the sum of all the rights and obligations contained within. These rights and obligations relate both to the activities undertaken by either party and the territorial limits under which the agreement is enforceable. Naturally, this is heavily dependent on the product in question and the parties involved. For instance, an investment bank may hire an investment adviser, while a detergent manufacturer may hire a distributor to sell its product. Both companies are distributors in their own right but the nature and scope of each agreement is different.
• Duration. The duration of the agreement refers to the time for which it is enforceable. Some distribution agreements have set time frames, while others have no set term. Having no time limit for a distribution agreement is advantageous to the Supplier as it allows a national company to remain in constant communication with its Distributor. However, this can also be risky if the Supplier has highlights the benefits and strengths of its product, especially overseas and has no control over its presentation. Conversely, setting a time limit is an effective way for a Supplier to monitor its Distributor’s activity. This also eliminates the need to continue supporting a Distributor’s activity if it has not proven effective over several years.
Different Categories of Distribution Agreements
In most distribution agreements, the supplier or manufacturer that enters into the agreement retains sole title and ownership of its products. While a distributor may take possession of the products for purchasing purposes to execute its order, legal title is not assigned until the distributor resells the goods to an end-user. Assuming the distributor fulfills its obligations under the agreement, throughout its tenure with the supplier, it will receive all the relevant rights to perform as the distributor.
In general, each supplier or manufacturer has the right to decide whether to enter into an exclusive, non-exclusive or sole distribution agreement. Exclusive distribution agreements are most commonly used for national agreements, whereas sole distribution agreements are most commonly used for area-wide agreements. Non-exclusive distribution agreements are common for local distribution agreements. However, there are many other factors that could cause some suppliers and manufacturers to favor one over the others.
Exclusive Distribution Agreements
Under an exclusive distribution agreement, the supplier agrees to supply products strictly to a certain distributor. Moreover, the distributor agrees not to sell the same products to competing suppliers and to perform all of its distribution services exclusively for the supplier.
The primary advantage to the supplier for entering into an exclusive distribution agreement is that it is essentially agreeing to market its products only to a single distributor. This can be advantageous in that the manufacturer or supplier does not have to worry about the sales made by its distributor to consumers or that competing distributors are receiving the same products from the supplier. Another potential benefit is for the supplier to gain access to additional markets or new territories without having to use any of its revenues to expand its own sale’s force. Competitors are also unlikely to enter an exclusive distribution agreement because doing so would give a distributor protection from competition with a similar distributor in the same territory.
The main disadvantage for the supplier in entering an exclusive distribution agreement is that if the distributor is unable to distribute the supplier’s products in the manner desired, the manufacturer is stuck with that distributor as opposed to having multiple distributors to choose from. This also means that if the sole exclusive distributor is under-performing, the supplier would have to wait until the end of the term of the agreement to change distributors.
Non-Exclusive Distribution Agreements
Under a non-exclusive distribution agreement, the supplier agrees to distribute its goods to a number of distributors. This agreement does not preclude (1) the distributor from distributing goods on behalf of any other supplier, or (2) the supplier from supplying product to any distributor, or (3) the manufacturer from selling product directly to consumers and competitors.
The primary advantage to the supplier from entering into a non-exclusive distribution agreement is that the supplier will be able to sell to a large number of various distributors, thus preventing any specific distributor from accumulating a monopoly over the distribution of the supplier’s goods.
The primary disadvantage to the supplier is that it no longer has the loyalty of a single supplier that is exclusively interested in the presence of the supplier’s products. Therefore, it is highly likely that the distributor will also attempt to sell similar products from competing suppliers or start selling competing products on its own at some point.
Sole Distribution Agreement
Sole distribution agreements are a hybrid of the exclusive and non-exclusive distribution agreements. Sole distribution agreements are used for a wider geographical area distribution in order to allow the supplier to gain control over the market for its goods. Under a sole distribution agreement, the supplier grants the distributor exclusive rights to market the goods in a specific territory and sometimes within a certain period of time. However, the supplier retains the right to distribute the product throughout the territory to itself and its own retailers.
One advantage to the supplier under a sole distribution agreement is that it will still receive a level of market control, but also has the ability to develop the market on its own if necessary. Moreover, a sole distribution agreement may allow a supplier to allocate a number of specific territories to a number of different distributors.
One disadvantage to the supplier under a sole distribution agreement is that it will receive little help from the distributor in developing the market for its products, since the distributor is limited to the exclusivity of that territory. Additionally, as similar to the exclusive distribution agreement, the supplier is stuck with its sole distributor for a period under the sole distribution agreement, whether the distributor is performing poorly or not.
Essential Provisions in Distribution Agreements
In a distribution agreement, there is a set of clauses generally contained in the contract. These clauses spell out the terms of the relationship between the parties while protecting the rights of both the distributors and the manufacturers. Some of these clauses include: Pricing and Payment terms -Pricing and payment terms are very important in a distribution agreement. The manufacturer will want to make sure that the pricing covers not only the cost of production, but also the cost of the distribution. The distributor will want to make sure that he obtains a fair price and incentives for his work. Termination -A distribution agreement should reasonably spell out how to terminate the relationship between the parties. Depending on the jurisdiction, the manufacturer will either have all the power to terminate the agreement or the distribution laws are geared towards protecting the distributor and provide for more difficult circumstances to terminate the agreement. Dispute resolution clauses -Companies both in distributing agreements and other commercial agreements will want to avoid litigation. Having a clear dispute resolution clause will generally provide for mediation and/or arbitration to resolve disputes.
Legal Aspects of Drafting Distribution Agreements
It is essential to consider local laws when drafting distribution agreements. In some countries, distribution agreements are subject to specific laws and regulations that must be followed. For example, in some jurisdictions, termination of a distribution agreement may require advance notice or a valid cause. If the distribution agreement does not comply with these regulations, it may be unenforceable in that country.
In addition, competition laws such as the EU’s Vertical Block Exemptions may also apply. These laws set out certain minimum requirements for competition compliance in the context of distribution agreements. Failure to comply to these laws may result in significant fines in the EU. Accordingly it is also necessary to consider these requirements when drafting a distribution agreement.
Finally , when drafting a distribution agreement it is important to provide for protections for intellectual property rights. In many countries, local laws prohibit the mere assignment of intellectual property rights. As a result, it may be necessary to license intellectual property rights to the distributor. Additionally, it may be necessary to actually register certain intellectual property rights in the local country, even if the rights are already registered in the home country or elsewhere.
Typical Pitfalls to Avoid
Distribution Agreements can be deceptively complex and both manufacturers and distributors can make errors when drafting and negotiating them. When they do, it can disrupt the entire manufacturing or distributing process. Consider these three most common mistakes and how to avoid them.
Failing to Address Termination. Termination clauses are the most important parts of any Distribution Agreement and it’s essential to outline the conditions under which an agreement can be terminated. Sometimes the cause of termination is clear such as a party’s bankruptcy or insolvency. But often, the reason isn’t so apparent or can be left open to interpretation. For example, agreeing that distributors may terminate the agreement on 30 days’ notice without cause is generally considered ineffective. All efforts must be made to define the term "without cause" so that its meaning is clear. The same holds true for "just cause". In California, any reference to just cause will be interpreted as requiring "good cause" to terminate or fail to renew.
Overselling or Making Incorrect Representations. It is easy to oversell the benefits or potential of a service or product and to include those statements in the Distribution Agreement. While these are arguably sales tactics, including express or implied representations of the viability of the services or products can be viewed as an unfair sales tactic and the maker may be liable for damages if any claims made turn out to be false.
Failing to Include a Warranty. Even the best products may experience defects and this is why it’s essential to have a warranty clause in the Distribution Agreement. Introductory clauses often include a warranty that is not based on fact but merely serves to entice the distributor into signing the agreement. The Warranty clause of the Distribution Agreement should state what the manufacturer’s liability will be if any of the products are defective and whether the liability will be for the manufacturing error or the design flaw, or both.
Negotiation of Distribution Agreements
Approaching the negotiation of a distribution agreement can sometimes feel like a high-stakes game of poker. To win, all parties must be willing to lay their cards on the table, revealing their basic positions and expectations of the agreement. The first step is to assemble the right team consisting of individuals who possess both the business savvy and the legal knowledge necessary to move the process from the beginning of negotiations to a final executed document. Generally, the best negotiating teams will have at least the following individuals involved: the person who has the authority to sign the agreement, the person who is contributing the product/information and the person who will be responsible for its resale as soon as possible after the signing.
Smart negotiators need to ensure that they’re considering the other contracting party’s needs and expectations, while at the same time, being mindful and protective of their own interests. A good negotiator should also be prepared for some compromise because no one will get everything that he or she wants.
When carefully reviewing a potential contract, the points which require the most negotiation will often depend on the relative sophistication of the persons to the agreement. Any agreement between two sophisticated businesses, such as manufacturers and distributors, will focus on the date and the price. The terms and conditions of the contract, or the boilerplate, will generally be non-negotiable.
More generally, when negotiating a potential agreement, you may find a few important factors including but not limited to:
Although it may be tempting to let someone else do the negotiating for you, the best negotiators take the time to carefully review each provision in the contract and make their own assessment of its importance before heading into the meeting. This is especially true when determining whether to accept various amendments during your negotiations. It’s important to exercise good judgment and discretion about these type of matters as you move forward with a distribution agreement contract.
When Distribution Agreements Are Breached
In enforcing a distribution agreement, the initial step is for the parties to first attempt to resolve their dispute amicably through communication and cooperation. If, however, the parties remain unable to resolve their dispute, formal proceedings addressing the terms of the distribution agreement may be required. Differences of opinion on the interpretation of contractual provisions, such as whether a given activity violates a non-compete, have resulted in court interpretation of those provisions and in some circumstances even led to contractual rescission. For example, in the case of Caledonian International, the Court of Appeals found that the company was not entitled to a declaratory judgment because a broker had no exclusive right to represent a supplier in the sale of certain products if the supplier had not sold the products in question. (Caledonian International v. Canon U.S.A., Inc., 75 A.D.3d 596 [N.Y. App. Div. 1st Dept 2010]). Another case which addresses the meaning and enforcement of an exclusive contract is Hanstrum v. Louis Agri-Systems, 73 A.D.2d 929 [N.Y. App. Div. 4th Dept 1979] . This case holds that while a contract must be performed in good faith, a manufacturer may terminate the exclusive relationship with the wholesaler because the wholesaler failed to fulfill its end of the agreement.
Even if a distribution agreement includes a clause providing for mandatory arbitration/arbitration in the event of any dispute arising under the agreement, parties are still entitled to seek injunctive relief from the courts of appropriate jurisdiction as an alternative to arbitration. An injunction is a court order requiring a person or entity to refrain from doing an action that threatens irreparable harm. "Irreparable harm" refers to the inability to repair damage caused at a later date. This could arise from loss of equity due to damage caused by newly encouraged competition as a result of a violation of the non-compete clause. In addition, a breach of fiduciary duty, such as the prospering of a business competitor at the expense of a company’s proprietary information, impedes the free flow of commerce, which results in irreparable harm. The prospect of money damages, even if the damages are significant, does not justify the damage because money cannot compensate a company for the irreparable harm caused by a breach.